Record Junk Sale Funds Fertilizer After Texas Blast: Muni Credit

An Iowa agency is set to offer the
largest-ever U.S. municipal junk bond sale to finance a
fertilizer plant two weeks after an explosion at a Texas
distributor of crop nutrients killed 14 people.

The Iowa Finance Authority plans to issue $1.2 billion in
tax-exempt debt this week to fund the building of a 320-acre
nitrogen fertilizer plant by Orascom Construction Industries,
Egypt’s biggest publicly traded company. Bond documents cite the
hazards of ammonia, which may have contributed to the Texas
blast, while saying that the facility won’t make solid ammonium
nitrate, the most explosive type of nitrogen fertilizer.

Even with the risk, high-yield investors such as Bill Black
at Invesco Ltd. (IVZ) and Dan Solender at Lord Abbett & Co. say
they’ll consider the debt, ranked three steps below investment
grade. They’re drawn by the deal’s scale and because the price
of natural gas, a fertilizer ingredient, is below its five-year
average. Lower-rated munis are rallying as buyers look for extra
yield with interest rates near generational lows.

“It’s going to be attractive to a lot of people because
its size should make it a bond people can trade,” said Black,
who co-manages the $7.2 billion Invesco High Yield Municipal
Fund (ACTNX) from Oakbrook Terrace, Illinois. “If you’re right that
this plant will succeed and perform, you should be rewarded with
decent improvement in the rating and the pricing on the bonds.”

Yield Appeal

The Iowa borrowing, the biggest from an issuer in the state
since at least 1974, is an example of tax-exempt bonds sold for
industrial development, which have accounted for the most
entities defaulting in the $3.7 trillion municipal market. Local
agencies sell the securities for companies, hospitals and
nonprofit organizations, whose credit backs the obligations.

Such securities also provide some of the highest yields.

Iowa’s sale may yield 1.8 percentage points more than AAA
munis, said Chris Ryon, who helps oversee $9.3 billion in local
debt at Thornburg Investment Management in Santa Fe, New Mexico.

Dan Toboja, vice president of muni trading at Ziegler
Capital Markets in Chicago, said the deal may be priced
similarly to a $295 million offer last week by an Ohio agency
for Genesis HealthCare System. The 2022 maturity in the issue
yielded 2.18 percentage points above AAAs.

That spread is more than double what investors demand to
own munis with a BBB rating, two steps above junk. The gap
touched 0.96 percentage point last month, the smallest since
September 2008, Bloomberg data show.

Historic Sale

The Iowa offer will eclipse a $750 million deal in 2007 for
West Penn Allegheny Health System in Pennsylvania. That was the
largest tax-exempt junk deal since at least 1990, Bloomberg data
show. An Indiana agency’s plan to issue $1.3 billion of similar
fertilizer-project bonds for a Pakistani company has been
derailed after the group’s products were linked by the U.S.
Department of Defense to improvised explosive devices used
against American troops in Afghanistan.

The nitrogen fertilizer industry is proposing about $20
billion of new plants and almost $2 billion of expansions across
nine states and three Canadian provinces, according to Mark Gulley, a New York-based analyst at BGC Financial LP.

Among the planned projects is CF Industries Holdings Inc. (CF)’s
proposed $1.7 billion expansion of a site in western Iowa. CF is
the largest U.S. maker of nitrogen fertilizer. An ammonium
nitrate blast at the same location in 1994, when it had
different ownership, killed 4 workers.

Safety Standards

The new plant in southeast Iowa “will have state-of-the-
art technology and the highest safety standards,” Omar Darwazah, Orascom’s investor relations manager in Cairo, said
via e-mail. “Some safe, easy-to-handle and non-explosive
alternatives are available that provide the same nutrients to
the soil” as ammonium nitrate, and the facility will produce
those instead, he said.

The venture will sell ammonia, granular urea, urea ammonium
nitrate and diesel exhaust fluid, offering documents show. While
authorities are still piecing together what happened in West,
Texas, it’s possible ammonia played a role, said John Verkade, a
chemistry professor at Iowa State University in Ames.

“Ammonia itself can be a mean customer” when stored in
tanks, he said in an interview. “Part of that huge fireball
might have been ammonia burning at quite a high temperature.”

One of the bondholder risks cited in offering documents is
“Hazardous Nature of Ammonia,” which the statement warns
“could cause severe damage or injury” and result in lawsuits,
fines or regulatory enforcement.

‘Wrong Time’

For investors such as Nicholos Venditti at Thornburg, those
risks, coupled with the narrowest high-yield spreads in more
than four years, mean he won’t be purchasing the securities.

“It’s just the absolute wrong time to be buying that type
of risk,” he said. “Credit spreads have compressed to as tight
as they’ve ever been, and it doesn’t help the cause when you
have something happen with multiple deaths.”

The April 17 Texas blast flattened 50 homes and injured
200. A nursing home, hospital and two schools are within a mile
of the facility.

The closest residents to the planned Iowa plant live a
quarter-mile away, said Gary Folluo, a member of the Lee County
Board of Supervisors. The local fire department has had multiple
meetings to discuss precautionary measures, he said by phone.

Job Producer

The plant will provide as many as 3,500 construction jobs
for the county of 35,617, and 165 full-time jobs once the
facility is operational, Folluo said. Lee County in February had
a jobless rate of 9 percent, compared with 5 percent statewide,
U.S. Labor Department data show.

Standard & Poor’s and Fitch Ratings both grade the project
debt BB-, three levels below investment grade. S&P said in its
report that construction “dominates credit risk” and that the
rating could increase to as high as BB+, one level below
investment grade, once the facility begins producing fertilizer.
The bonds mature from 2019 to 2025.

The plant benefits from its location in Iowa, the biggest
corn-producing state and the largest consumer of nitrogen-based
fertilizer, while also bordering Illinois and Missouri, which
will lower transportation costs, Folluo said.

“People are excited -- it could be the start of a new
sector in high-yield,” said Toboja at Ziegler.

The Iowa sale will represent about 20 percent of the $6
billion of planned muni borrowings this week, in the smallest
issuance wave since March, data compiled by Bloomberg show.

Ten-year benchmark munis yield 1.76 percent, close to the
lowest since January. The tax-exempt bonds are still cheaper
than similar-maturity Treasuries, which yield about 1.66
percent.

The yield ratio between the two securities is 106 percent,
the highest in about three weeks. The greater the figure, the
less expensive munis are compared with federal debt.